Cold Winter on Wall Street

MAYOR Keith L. Gillins wants to know if there is an investment banker in the house. Fillmore, Utah, the city he runs, needs a new pool where children can learn to swim; the old one, he said, is ''pretty dilapidated.''

His problem is raising the money. Government grants are scarce. And until Congress revised the tax code, he might have been able to tap the tax-exempt markets. That's now ''out of the question,'' he sighed.

With most of Wall Street retrenching, awash in red ink from a colicky stock market, Mr. Gillins is beginning to despair of ever getting Wall Street's attention. Like many smaller users of financial services, he may be in for a rough ride if consolidation on Wall Street - mergers of firms, layoffs of hundreds of people - continues at the stampede pace of the last couple of months, as most people expect.

The reverberations from the cutbacks will be felt even by larger customers; most will keep getting financing but may lose the special services that used to go along with it. Others, especially small municipal projects or startup ventures, may see their access to the capital markets pinched. And small retail investors who are clients of large retail firms may see the service get more impersonal.

Perhaps most important, the entire financial marketplace may be at greater risk if a handful of marketmakers or specialists - the traders entrusted with making orderly markets in assigned securities - end up with too big a slab of volume. If any one of them got into financial trouble, the market could conceivably be brought down, too.

But over all, the churning inside Wall Street's brokerages and investment banks has not proved cataclysmic to people outside the financial district and New York City's economy. As the stock market rose and these firms made out like bandits, few outside Wall Street shared in their enormous wealth. Now, as Wall Street writhes, its clients and the economy seem pretty well insulated. Nor are things likely to get so out of hand that it will begin to make a big difference to most people.

RETRENCHMENT is not a new phenomenon in the brokerage industry, which typically shrinks when the market hits hard times. In fact, Wall Street is probably far better prepared now than it was the last time the industry underwent a major consolidation in the early 1970's. Firms have a much broader portfolio of products to peddle and are therefore less vulnerable to the vicissitudes of any one market. Stronger ties in global markets have also increased the customer base - and the amount of capital - that can pour into the system. And the outlook for corporate earnings is quite bullish.

''I don't think business on Wall Street has come to a screeching halt,'' said Samuel L. Hayes 3d, a professor at the Harvard business school. ''Business continues to go on. Firms have 6,500 employees working 12-hour days and that hasn't slacked off.'' To fully appreciate how consolidation has reshaped Wall Street, thumb through the financial pages of an old newspaper.

A 1956 advertisement honoring the Ford Motor Company, for instance, featured many of the 722 firms that participated in its first public stock offering. Kuhn, Loeb. White, Weld. Lehman Brothers. ''My guess is there are only 50 of them still in business in the same form,'' said Harold Tanner, a 30-year veteran in investment banking.

The most recent companies to go out of business or to be sold, of course, were victims of October's stock market rout. But the consolidation sweeping through Wall Street - which eliminated firms and created several financial service giants - began in earnest long before October. Some trace it to Donaldson Lufkin Jenrette's 1970 decision to go public, which was imitated by nearly every other private partnership on the street. The switch made even the most pristine firms vulnerable to takeovers if their earnings faltered.

Washington did its part in forcing major change on Wall Street. It opened brokerage commissions to competition in May 1975, and in 1983 it approved ''shelf registrations,'' which cut the time and paperwork required to bring a security to market. The new simpler rules forever altered what was a gentleman's business. No longer would a firm get a chunk of business - or its asking price - simply because of longstanding ties.

October's market jolt claimed some big names: E. F. Hutton agreed to be bought by Shearson Lehman, itself a unit of American Express. L. F. Rothschild put itself up for sale, though it is unclear whether a buyer will surface. Several specialist firms also went up for grabs.

But if the experience is nothing new, that does not ease the pain for many in the industry. Several thousand professionals have already lost their jobs and there are no signs that the pink slips are letting up. ''Some of the bigger cuts may come later rather than earlier,'' said Ernest Bloch, author of the book, ''Inside Investment Banking.'' ''There's a kind of institutional inertia where it's the personnel people who do the recruiting and they want to keep their jobs. So they want to look busy and that maintains the momentum.''

But the concentration of power has had minimal effect so far on pricing and competitive dynamics. And in a year when the Federal Government has shown some vigor in enforcing antitrust laws, regulators have made no public outcry against mergers between financial giants.

THAT'S fine with major Wall Street firms. They believe customers will not be hurt by the consolidation because competition has never been keener. ''There's enough of a market out there that if one or two people disappear or five or 10 people disappear, it won't affect people at all,'' said James E. Cayne, co-president of Bear Stearns.

Joel R. Mesznik, a municipal finance specialist at Drexel Burnham Lambert, pointed out that competition has not eased yet, and that ''the street is still killing itself trying to supply capital.'' He cited the examples of four municipal borrowers which come to market frequently: the states of Missouri and Hawaii, the Los Angeles Department of Water and Power and the Port Authority of New York and New Jersey. In each case, at least as many underwriters submitted bids as have on past deals.

There are also plenty of people who believe consolidation only purges weaker firms from the system and enables stronger ones to enjoy economies of scale and plumper spreads. ''Maybe what comes out of this is a healthier environment,'' said John F. Perkowski, head of investment banking at Paine Webber.

Perrin Long, an analyst at Lipper Analytical Services, said concentration has stabilized competition in other industries. ''For the average person, I don't think there's any reason to be concerned,'' he said. ''The average person is not concerned that we only have three major automobile companies, three cereal companies and three major networks.''

Lowell Bryan, a McKinsey & Company consultant who specializes in financial firms, is not concerned as long as a standardized test and a modest amount of capital constitute the only entry barriers into the profession. That way, he said, foreign firms, commercial banks and those who are laid off can easily replace some of the institutions that are sold or go out of business.

But Jeffrey M. Schaefer, a researcher with the Securities Industry Association, warns that the proliferation of startups is deceptive. ''What you lose in looking at numbers is the disappearance of a few very large firms like a White Weld or Lehman or A. G. Becker. No matter how many new firms come into the industry, you never capture that,'' he said.

Indeed, while the number of firms registered with the National Association of Securities Dealers has more than doubled between 1977 and 1986, the number of Big Board firms doing a public business, which tend to be larger, has essentially been flat.

As the consolidations continue, corporate clients are probably in better shape than municipal issuers. But service is deteriorating and small business is getting jittery.

''I think there is a real capital formation crisis on the horizon, particularly for smaller business,'' said Brian Carty, executive director of the Massachusetts Industrial Finance Agency, which issues bonds for pools of small and midsize companies.

FINANCINGS that two months ago were ''no-brainers'' are now almost impossible to do, he complained, mainly because the market collapse has prompted bondholders to insist on dealing with only the best-capitalized borrowers, and underwriters are doing less prospecting for new business.

''In the past, underwriters have been delighted to work with us,'' he said. ''With the market retrenchment and consolidation, my fear is they will overlook this end of the market and stay with bigger transactions.''

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Even larger clients can detect fine changes in the price and the level of service they receive. Some firms are charging more for bridge loans, which tide acquirers over until they can raise capital in the public markets. And institutional investors are paying more in trades where firms must use their own capital to facilitate the transaction.

It has not happened yet, but corporate and municipal customers might also see a decline in innovation. Regulators may outlaw certain cutting-edge products such as derivative securities, whose applications are still being discovered. But the firms may do the rest themselves if, in their haste to improve the productivity of their workforce, they prune the people who come up with new ideas.

EVEN if firms do not cut back on the dollars they devote toward research and development, Mr. Tanner, who now runs his own investment boutique, Tanner & Company, thinks that one danger of consolidation is that it stifles creative thought.

''Historically,'' he said, ''whenever these firms have been owned by large organizations it's been difficult to maintain the same level of entrepreneurial activity. And now there are the risks that you will not attract the same type of entrepreneur that you had before or that the firms will operate on a bureaucratic basis.''

One corner of Wall Street where consolidation raises some scary questions is at the floors of the major exchanges and in over-the-counter trading. They are almost invisible to the trading public, but the specialists on the exchanges and the firms that make markets by buying and selling particular securities have a profound influence on the market.

The events of October made it painfully clear that the specialists and the marketmakers, while well-equipped to deal with ordinary trading days, can be overwhelmed by the kind of volume surges that have occurred. Some of the arranged marriages made in the days following the crash brought deeper pockets to the exchanges and the prospect of more such mergers is welcome by many.

Kenneth R. Leibler, president of the American Stock Exchange, said he would not be suprised if the number of specialist firms on his floor dropped to 12 from 24 over the next couple of years as the need for capital grows. ''Less than a dozen would begin to give us concern,'' he said. ''But the percentage accounted for by any one of them is of more concern than how many there are in total.''

Both the New York and American exchanges monitor the market share held by their specialists to insure that no one firm can cause a market meltdown. But October forced some tough decisions. For instance, American Stock Exchange guidelines bar acquisitions that would leave a firm with more than a 15 percent share of trading volume. Spear Leeds & Kellogg's October agreement to purchase Santangelo & Company, which was running out of capital at the time, looked like it might put the firm over, but the exchange approved the buyout. ''On October 19 we were not going to schedule a meeting and debate the issue,'' said Mr. Leibler. ''It was an emergency. But as an ongoing matter, we'd like to take the time to review those more carefully.''

The mergers raise similar issues in the over-the-counter market, as the consolidation chisels away at one of its key sales points: multiple marketmakers are better than one. Shearson's purchase of Hutton is an example. Both firms make markets in 400 of the same over-the-counter stocks. Now those stocks will have one fewer marketmaker.

Joseph R. Hardiman, president of the N.A.S.D., said he is not troubled by a slight drop in the number of firms that stand willing to buy or sell a particular security.

''If we reduced our marketmakers by 10 or 15 percent, but the remaining marketmakers are well-staffed, wellcapitalized and committed, the process will have been strengthened, not weakened,'' he said.

Small investors are not happy about the trend toward larger and larger retail firms. They are not thrilled about getting the same recommendation as thousands of other clients. They say firms focus on richer and richer prospects. But they can always seek out smaller brokerages.

DAVID FLEMING, a securities attorney in New York who typically has between $50,000 and $100,000 in the stock market at any time, said he felt like a number when he was a client at Merrill Lynch. ''The broker who had initially solicited me left, and in the interim they assigned me to a client services department and a phone number,'' he said.

He still has an active account at Shearson - mostly because a relative works there - but he prefers dealing with a smaller boutique.

''When special opportunities come up, you're higher on the list,'' he said.

Steven Rosen, a dentist in Queens, also opened accounts at several large wirehouses when he was younger, but then he got tired of not knowing who he was dealing with - and not being able to reach the boss. ''Who owns Merrill Lynch?'' he asked. ''You can't call Mr. Merrill and complain or get some advice. You can't call Merrill or Lynch or Hutton or Shearson.''

The handwringing over Wall Street's consolidations seems most justified on the municipal side of the business. That side was already reeling from sweeping changes in the tax code, which eliminated many tax breaks that municipal issuers and bondholders had enjoyed. ''There are a lot of services provided by municipalities through raising tax-free money that they can no longer provide,'' said Evelyn Wolff, an associate director at Bear Stearns.

Mr. Mesznik, the Drexel specialist, said he thinks the financings will get done - but their cost will rise because they will have to be designed as taxable securities.

''It is obvious that the tax bill has limited the tax-exempt bond market as it was supposed to do,'' he said. ''But it is also obvious that the public-sector capital needs don't change because of the tax bill.''

NOW several large players have withdrawn from the market - including the market leader Salomon Brothers - and it may be some time before large rivals decide to pick up the slack as long as prices remain low.

''Salomon was an important market maker; it's going to require effort on the part of the remaining players to close that gap,'' said Professor Hayes. ''One thing that has been blamed on Salomon is they killed the market because of their aggressive pricing and as soon as they killed it, they walked away leaving everyone with razor-thin margins.''

He said, however, that Congress will eventually dismantle the legal wall keeping commercial banks out of this arena. Banks can underwrite general obligation bonds, but not revenue bonds, which account for 75 percent of the volume, he said.

Mr. Gillins, for one, cannot wait much longer for Washington to act. His pool's estimated cost may not be enough to get Wall Street's attention.